A Subsidy Primer

A Subsidy Primer by Ronald Steenblik Global Subsidies Initiative of the International Institute for Sustainable Development Geneva, Switzerland Table of Contents Preface and Acknowledgements 4 GETTING TO KNOW SUBSIDIES 6 Why Be Concerned about Subsidies? 6 What is a Subsidy? 8 Penetrating the Rhetoric of Subsidies 9 The Notion of Specificity 10 THE EFFECTS OF SUBSIDIES 12 The Opportunity Cost of Subsidies 1 The Static Effects of Subsidies on Efficiency 13 The Dynamic Effects of Subsidization 14 The Distribution of Subsidies 15 Effects on the Environment 16 The Political Economy of Subsidies 17 SUBSIDY TYPES 18 Grants and other Direct Payments 18 Market Price Support 19 Tax Concessions 0 In-kind Subsidies 1 Cross Subsidies Credit Subsidies and Government Guarantees 3 Hybrid Subsidies 4 Derivative Subsidies 5 Subsidies through Government Procurement 6 THE MATERIALS AND TOOLS OF SUBSIDY ANALYSIS 28 Basic Data 8 Sectoral Subsidy Accounts 9 Large computerized models and their Ilk 30 INTERNATIONAL DISCIPLINES ON SUBSIDIES 32 Trade and Subsidy Regulation 3 The WTO Agreement on Subsidies and Countervailing Measures (ASCM) 33 The Agreement on Agriculture: an overview 34 The Agreement on Agriculture: the boxes 35 The General Agreement on Trade in Service (GATS) 36 Dispute Settlement at the WTO 37 Soft Law on Subsidies 38 CIVIL SOCIETY AND SUBSIDIES 40 Private Efforts to Control the Abuse of Subsidies 40 Green Scissors (USA) 41 Farmsubsidy.org (Europe) 4 International Budget Project (International) 43 Sources and Suggested Readings 44 3 Preface and Acknowledgements The International Institute for Sustainable Development’s Global Subsidies Initiative (GSI) was launched at the end of 2005, just prior to the WTO Min- isterial Conference in Hong Kong, China. Delegates to the WTO meeting had gathered from around the world to discuss a wide range of issues being negotiated as part of the Doha Round of multilateral trade talks, but topmost on their minds were subsidies. What to do about agricultural subsidies, and market access (tariff and non-tariff barriers), was, as always, the make-or-break issue. But also on the table were various proposals for sharply reducing subsidies to fisheries, and perhaps eventually developing new “disciplines” on subsidies affecting trade in services. Yet despite the fact that subsidies have become a central issue on the international agenda, the available information on subsidies is both highly dispersed and highly technical. While many valuable contributions have been made over the years to the literature of subsidies, most have been in the form of scholarly articles or books written by and for economists or trade experts. These tended to be either monographs focused on the magnitude of subsidies or their effects, or popular diatribes aimed at ridiculing subsidies in particular countries. For anybody approaching the subject anew, they would face a steep learning curve indeed. Subsidies are not difficult to understand, but because the terms and definitions used by individual policy communities differ, confusion is vir- tually guaranteed. What was needed, in brief, was a book that covered all the issues related to subsidies, yet was short enough and accessible enough to attain a wide readership. In producing this Subsidy Primer we are attempting to fulfill that need. The structure of the book has been set out so that each topic is addressed on a single page. While every effort has been made to ensure accuracy and balance, no doubt some readers – particularly economists and trade lawyers – may find that certain details or elaborations have been left out. Others may find that some of the statements are too sweeping. If so, we encourage reader feedback and will endeavor to take it into consideration in any future revisions of the book. 4 Portions of this booklet draw on earlier work by the author, particularly two papers prepared for the World Conservation Union (IUCN) and the Pacific Economic Co-operation Council (PECC), for the former’s 50th anniversary conference and the latter’s workshop on fish subsidies, both of which took place in 1998. These papers have been subsequently published in proceedings, but remain obscure. 5 GETTING TO KNOW SUBSIDIES Why Be Concerned about Subsidies? Why should you, as a citizen, care about subsidies? After all, don’t many subsidies serve useful purposes? Yes, they do. Subsidies enable children from poor families to attend higher education. They support research vital to developing new vaccines and predicting natural disasters. And they help unemployed people to learn new skills, or to relocate to areas with better job prospects. But precisely because government expenditure is limited, citizens should care about subsidies if for no other reason than to ensure that they serve the pub- lic interest and not merely private ones. Nothing speaks louder about a government’s actual intentions and activities than how it spends its money, your money. A lawmaker may proclaim support for energy conservation, yet still vote for generous tax breaks to buyers of large, gas-guzzling vehicles. A president may lecture an international gathering on the importance of helping developing countries to export their way out of poverty, and later that same day approve a new subsidy that effectively blocks imports from those same countries. The second reason to care about subsidies is that they can have profound and long-lasting effects on the economy, the distribution of income in society, and the environment, both at home and abroad. Subsidies have shaped the pattern and methods of agricultural production, even in countries that provide few or no farm subsidies. They have encouraged fishing fleets to search farther and deeper than ever before, aggravating the problem of over-fishing. They have fueled unsustainable energy production and consumption patterns. And, most worryingly, they continue to do so. 6 Notes 7 What is a Subsidy? The word subsidy is derived from the Latin word subsidium, which meant “support, assistance, aid, help, protection”. In medieval times it referred to a payment made to the king. While the definition has since moved on from that, the habit of royalty accepting subsidies has not. Research carried out by Farm- Subsidy.Org, for example, has shown that in 2004 the Queen of England and the Duke of Westminster each received half a million pounds sterling in farm subsidies, and Prince Albert of Monaco €287,000. Republics like France and the United States no longer have sovereign rulers, but some of their farmers live like kings, thanks to generous subsidies. Nowadays, to most people, a subsidy means a payment from a government to a person or company. Many subsidies are indeed provided in that form, as grants or, more generically, direct payments. Grants are the elephants in the subsidy zoo: they are large and highly visible. But there are numerous other subsidy beasts which are better camouflaged, stealthier, and keep closer to the ground. The only internationally agreed definitions of a subsidy are those of the United Nations Statistics Division, which is used for the purpose of constructing national accounts, and of the World Trade Organization (WTO), which is used for the purpose of regulating the use of subsidies that affect trade. The WTO definition is the more comprehensive of the two and can be summed up as follows: A subsidy is a financial contribution by a government, or agent of a government, that confers a benefit on its recipients. There are many people in the world, particularly environmental economists, who would like to add to that definition. But for the purposes of this Primer it provides an adequate entry point to the topic. 8 Penetrating the Rhetoric of Subsidies The English language offers a rich vocabulary for expressing the notion of subsidy. Familiarization with these synonyms is useful both for understanding the rhetoric of subsidies and for conducting literature and data searches. State aids is the term used within the European Union for subsidies provided by its Member States. It is used also by some U.S. states. “Aid” by itself, because of its common association with foreign aid, is used less frequently than in the past to mean a domestic subsidy. Industry assistance is a more general term than subsidy, and can include low-cost general services, such as advice to small businesses on how to fill in their tax forms. Lawmakers like speaking of aid or assistance because the terms are subtly suggestive of short-term help or relief, even though the programmes involved may be long-running. The word “support” has a precise meaning within the trade-policy commu- nity. The OECD, for example, refers to support when discussing its aggregate of subsidies and transfers to producers created through artificially high prices (i.e., market price support), the producer support equivalent, or PSE. Domestic support and aggregate measurement of support are terms used in reference to obligations under the WTO’s Agreement on Agriculture. In the political sphere, however, “support” is highly imprecise. When a government declares it “supports” a particular technology, industry, or sector, that “support” can mean anything from simple well wishes to suitcases of money. Perhaps the most ambiguous euphemism for “subsidy” is incentive. That is because an incentive can be positive or negative. For example, use of a relatively clean form of energy can be stimulated either by a tax on more-polluting forms of energy, or through a subsidy to consumers of the cleaner energy. The budget- ary implications of the two forms of incentive could not be more different. 9 The Notion of Specificity One of the important distinctions used by economists and lawyers interested in the trade or competition effects of subsidies is between specific and non-specific subsidies. Specific subsidies go to particular groups of beneficiaries, as opposed to the population as a whole.

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